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Investment Funds

Overview of Investment Funds

I. Direct vs. Indirect Investment

  • Direct Investment:
    • Individual investors personally buy assets (e.g., shares in a company).
    • Example: Buying shares of Apple.
  • Indirect Investment:
    • Individual investors buy a stake in an investment fund that pools money.
    • Example: Investing in a mutual fund that holds shares of various companies (possibly including Apple).
  • Attraction of Indirect Investment: Direct investment can be costly and difficult in terms of time and effort, so indirect investment is more attractive for many individuals due to the diversification benefits they offer.

II. Collective Investment Schemes (CISs)

  • Definition: Pooled funds where the resources of many investors are combined.
  • Synonyms: Funds, collective investment vehicles, mutual funds, unit trusts, open-ended investment companies (OEICs).
  • Open-Ended Funds:
    • Can create new shares in response to investor demand or cancel shares when they are sold, allowing the fund's capital to expand or contract.
    • Example: Mutual funds.
  • Closed-Ended Funds:
    • Have a fixed capital base, where investors buy or sell shares to other investors.
    • Trades happen on stock exchanges.
    • Example: US closed-ended funds.

III. International Fund Structure

  • Undertakings for Collective Investment in Transferable Securities (UCITS):
    • Funds established in Europe and marketed internationally that comply with EU regulations.
    • The UCITS branding is seen as a measure of quality, which makes them acceptable for sale in many countries in the Middle East and Asia.
  • Popular Centres for Fund Establishment:
    • Luxembourg (often structured as a Société d’Investissement à Capital Variable - SICAV)
    • UK, Ireland, and Jersey (often structured as an OEIC or unit trust)
  • International Nature of Fund Business:
    • Many funds are established in one country but are marketed internationally.
    • Example: In Bahrain, over 1,700 funds are registered for sale, with domiciles ranging from Bahrain, to international fund management houses such as BlackRock, Fidelity and JPMorgan.

IV. Benefits of Collective Investment

  • Economies of Scale: Reduced transaction costs through pooled funds.
  • Diversification: Access to a broader range of investments, sectors, and markets.
  • Professional Management: Access to the expertise of professional fund managers.
  • Access to Markets: Exposure to geographical markets, asset classes, or strategies that might be inaccessible to individual investors.
  • Regulatory Oversight: Many funds have regulatory oversight, leading to investor protection
  • Tax Deferral: Certain funds may allow tax deferral for certain investors.

Diversification in Detail

  • Reducing Risk: By holding a range of different investments, any single investment falling sharply can be offset by an increase in value from other investments, reducing the risk of total loss.
  • Minimum Investment: Individual investors with small amounts to invest are not disadvantaged by minimum commission costs on different investments, because collective investment schemes allow for the pooling of funds.
  • Sector Diversification: Investment funds also ensure diversification is achieved from an industry perspective.
  • Asset Allocation: Some funds also invest in other types of assets, such as bonds, cash, or even other funds.

Access to Expertise

  • Fund Managers' Skills: Investors can use the expertise of professional fund managers who follow markets closely and make informed investment decisions.
  • Fund Managers' Fees: Managers do charge fees to investors to cover salaries, technology and research.
  • Active vs Passive: Recent research shows that many actively managed funds fail to beat benchmarks, which has led to a growing debate between actively and passively managed funds.

V. Investment Strategies

  • Investment Objectives: Funds are managed based on stated objectives (e.g., capital growth, income maximization, steady growth).
  • Investment Style: The fund manager’s approach to choosing investments and meeting the objectives.
  • Investment Portfolio: Managed by the fund manager according to the stated set of objectives and using a clearly defined investment style.

1. Passive Management

  • Definition: Mimics the performance of a recognized index (index-tracker funds).
  • Assumption: Markets are efficiently priced and cannot be consistently outperformed.
  • No Forecasting: No attempt is made to forecast future events or outperform the broader market.
  • Advantages:
    • Few active managers consistently outperform benchmark indices.
    • Lower costs due to reduced staff and lower portfolio turnover.
  • Disadvantages:
    • Tracking Error: Inability to completely match the performance of the underlying index.
    • Dividend Reinvestment Issues: Funds can only invest dividends after they are received (up to six weeks after ex-dividend date).
    • Index Limitations: Indexed portfolios may not meet all of an investor’s objectives, and follow the index down in bear markets.

2. Active Management

  • Definition: Seeks to outperform a benchmark by employing forecasting and analysis.
  • Analysis Types:
    • Fundamental Analysis: Focuses on economic and company-specific factors.
    • Technical Analysis: Focuses on patterns in data to forecast future price movements.
  • Fee Structure: Actively managed funds usually have higher charges than passively managed funds.
  • Investment Approaches:
    • Top-Down: Focuses on economic and industry trends.
    • Bottom-Up: Focuses on company-specific indicators (e.g., net assets, profitability, cash flow).

VI. Fund Classification

  • General Categorization: Funds are broadly categorized based on their primary investment objective.
  • Common Classifications:
    • Income Funds: Aim to generate a steady stream of income.
    • Growth Funds: Focus on capital appreciation over the long term.
  • Capital Protection Funds: Aims to maintain the principal amount invested, as well as grow the capital. * Specialist Funds: Funds that focus on a single sector or specific investment strategy * Volatility Managed Funds: Funds that use various strategies to manage risk and reduce the volatility of returns. * Absolute/Target Return Funds: Funds that aim to achieve a set level of return within a specific timeframe. * Unclassified: Funds that do not fit easily into other categories.

In Summary

Investment funds provide investors with a way to access a range of markets, assets and investment strategies that may not otherwise be accessible to individual investors, and are usually structured as pooled funds, which also provide some diversification benefits. It is important to be aware of the key differences between active and passive investment management styles, and also to be clear on the fund objectives and its overall classification, so that investments can be matched to the goals of the investor.

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